Interviewing John Hussman: ‘The Market Is Overvalued By 100%’

Interviewing John Hussman: “The Market Is Overvalued By 100%” (PeakProsperity, Nov 8, 2014):

John Hussman is highly respected for his prodigious use of data and adherence to what it tells him about the state of the financial markets. His regular weekly market commentary is widely regarded as one of the best-researched, best-articulated publications available to money managers.

John’s public appearances are rare, so we’re especially grateful he made time to speak with us yesterday about the precarious state in which he sees global markets. Based on historical norms and averages, he calculates that the ZIRP and QE policies of the Fed and other world central banks have led to an overvaluation in the stock market where prices are 2 times higher than they should be:

John Hussman:  What’s interesting here is that if you think about equities, they’re not a claim on next year’s prediction of earnings by Wall Street analysts. A stock, in fact any security, is a claim on any long-term stream of cash flows that investors can expect to be delivered to them over a very long period of time.

When you look at equities you can calculate something called duration. It’s essentially the effective life of a security over which you are collecting cash flows in return for the amount you pay. For the S&P 500 the duration is about 50 years. In other words it is a very, very long-term asset. The only reason you would want to price that asset based on your estimate of next year’s earnings is if you were convinced that next year’s earnings are actually representative of the very, very long-term stream — and I’m talking 50 years or so of earnings that you’re likely to get — that those earnings are in a sense accurately proportional to the whole long-term stream.

What’s amazing about that is that is it has never been true. It has never been true historically. If you look at corporate profits and especially corporate profit margins, they’re one of the most cyclical and mean-reverting series in economics. Right now, we have corporate profits that are close to about 11% of GDP, but if you look at that series you will find that corporate profits as a share of GDP have always dropped back to about 5.5% or below in every single economic cycle including recent decades, including not only the financial crisis but 2002 and every other economic cycle we have been in.

Right now stocks as a multiple of last year’s expected earnings may look only modestly over valued or modestly richly valued. Really if you look at the measures of valuation that are most correlated to the returns that stocks deliver over time say over seven years or over the next 10 years the S&P 500 in our estimation is about double the level of valuation that would give investors a normal rate of return.

So right now, we’ve got stocks valued at a point where we estimate the 10 year prospective return on the S&P 500 will be about 1.6 to 1.7% annualized — talking right now with the S&P 500 at 2032 as of today’s close.

Chris Martenson: I guess 1.6 or 7% doesn’t sound bad if you are getting 0% on your risk-free money, I guess. But this says that any move by the Fed to normalize — which means rates have to go up — any move to drain liquidity from the system is going to have its own impact. If we held all things equal, a normalization effort is going to then basically expose that the stock market is roughly overvalued by 100%.

John Hussman:  100%, yes. I actually think the case is a little bit harsher than that; in fact, quite a bit harsher than that.

The idea that well, “1.7% isn’t so bad” or “1.6% isn’t so bad” ignores the fact that really in every market cycle and economic cycle we have had a point where stocks were fairly valued or undervalued.The only cycle in which we didn’t see that was actually the 2002 low where stocks actually ended that decline at an overvalued level on a historical basis.  But valuations were still relatively high on a historical basis in 2002. They got slightly undervalued in 2009, but not deeply.

On a historical basis, what’s interesting is that if you look at measures of valuation that correct for the level of profit margins, you actually get about a 90% correlation with subsequent 10 year returns. That relationship has held up even over the past several decades. It has held up even over the past 5 years where the expected return that you would have forecasted based on time-tested valuations turned out to be pretty close to what you would have forecasted 10 years earlier.

Right now, like I say, we are looking at stocks that have been pressed to long-term expected returns that are really dismal.But more important than that, in every market cycle that we’ve seen with the mild exception of 2002, we’ve seen stocks price revert back to normal rates of return. In order to get to that point from here, we would have to have equities drop by about half. 

This is one of the highest-quality and deepest-diving podcasts we’ve recorded in the 3-year history of our series. Part 1 is publicly available below. Part 2 can be accessed here (enrollment required). 

1 thought on “Interviewing John Hussman: ‘The Market Is Overvalued By 100%’”

  1. Looking at it from over here, I am not terribly well versed in all that he discusses. However, the stock market is so removed from the real market, 100% over valuation seems optimistic to me……I think the problem is even worse. What he did not address was the quality of the securities. 85%+ of ALL transactions are high frequency, formerly illegal skim and sell in a time space faster than the blinking of an eye. The key word is sell.

    A few individuals, controlling huge funds (at least on paper) buy and sell large amounts of securities in the blink of an eye. I call it skim and sell, and it used to be highly illegal. If you held stock for less than a year and a day, it was taxed at short term capital gains, if you sold after that time, it was long term capital gain taxes, quite kinder. These clowns pay NO TAXES. They are often given a heads up before the bell (also highly illegal) so know what to play before hand. The real investors are not privy to any of this, and we still have to play by the rules. If we sell, we wait several days for the check…….it is so slanted in favor of greedy guts at the expense of the rest of us, that nobody with any brains is playing the market these days. The day of the “Day Traders” of people like me, is lost. We cannot hope to compete.

    Only 10-15% of all transactions are genuine. That tells me the market is inflated by 85-90%, just as it was in 1929. The market went down 90% between 1929-33……and the numbers are far bigger this time, and much of it is by using leveraged funds. In 1929, a person could open a brokerage account with $100 in cash, and could buy $190 worth of stock. Today, it is leveraged 1000:1. You do the math, I cannot bother, the numbers are insane, just like the greedy guts in it.

    2007-08 will look like a Sunday picnic by comparison. This time, there is no money to pick up the slack, the money is gone, spent, and money has a way of disappearing after you spend it… can only spend it once. The US was at the top of the world, now it is bankrupt, it’s credibility and markets are gone, and it is no longer the world reserve currency. Only 33% of the world economies use the dollar, and when the EU falls apart, the dollar will collapse.
    A few states of the EU will go with BRICS or the Eurasian Union……and the dollar will be totally finished. It is close to the end, now.

    No more than 15% of the market is made up of real money, the rest is all on paper.


Leave a Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.